Sector Rotation in Tech: Time to Reboot?

December 5, 2017 | Simpler Trading Team

Monday was the first day of open market trading following the approval of the Tax Reform Bill by the Senate. The day’s session saw winners across almost all boards in the Dow and S&P. Many sectors saw huge spikes with the promise of corporate tax cuts, and provisions within the new bill that would benefit specific industries. One industry, however, was a winner in the bill but a loser in the market.

Technology.

While other sectors were thriving, the technology industry saw a down day. That’s odd considering that tech has been the S&P’s top performing sector overall in 2017. As of December 1st 2017, the Technology Select Sector SPDR ETF (XLK), which tracks the performance of the technology sector, was up 32.8% on the year.

It wasn’t, however, just Monday’s session that saw tech struggle. The sector has lost majority of sessions over the last week. In fact, the XLK returned 1.4% of its gains in the month of November as major tech stocks including Apple (AAPL), Microsoft (MSFT), and Facebook (FB) all gave back more than 1.5% of their gains.

Instead of tech, traders have been rotating into financials, telecoms, and transports; all groups projected to benefit massively from the Senate’s Tax Reform Bill and corporate tax reduction.

If you’re new to trading, sector rotation is a strategy where a trader shifts focus (and funds) from one industry sector to another in order to target the strongest sectors and avoid the weakest ones. This strategy is based on the idea of market cycles. When traders feel they’re seeing a market top, switching to another sector lets them stay ahead of the market.

That’s what’s happening in the market, as money is leaving tech, 2017’s best performing sector, for some of 2017’s worst performers who look primed to surge thanks to tax reform.

It’s not that the tax bill was bad for tech. In fact, these tax cuts and repatriation tax allow tech companies to bring their overseas war chests back into the U.S.

There’s a lot to like about tech in that regard.

But, in this case, tech is a victim of its own success. It nearly doubled the performance of the S&P 500 in 2017. After such strong gains all year, the sector’s stocks may be overpriced for a lot of traders.

Traders can spot a lot of undervalued sectors with even more potential as price, profit potential, and value all intersect. The best example of this is one of the biggest gainers of the day from Monday’s session – telecom.

Telecommunication companies have been subjected to some of the highest effective tax rates among publicly traded corporations.

Now that their tax rates will be slashed from 35% to 20%, traders are took positions with the expectation that shares will soar. This caused the sector to jump 1.6% on Monday.

Another sector that jumped 1.6% is financials. With promised faster economic growth comes loan portfolio expansion. As corporations find themselves with lower tax rates, many will look to take on more loans and expand their operations. The result may boost banks in a big way. As the clear winner in the tax reform passage, financials are set to be one of the biggest performers in the coming quarter.

One thing to keep in mind is that all this activity is based on the Tax Reform Bill.

Bill.

Not law.

Should a tax reform bill fail to make it into law, this can all change. That’s just how the market works. But given that both the House and Senate have finally agreed upon respective versions of a tax reform bill, passage into law is likely. As such, sector rotation out of tech and into undervalued markets such as financials and telecom looks like a strong play until tech is ready for a reboot.

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